House of Lords and NAO raise concerns with IR35

Just under a year ago, reforms to the off-payroll working rules known as IR35 were rolled out in the private sector.

Since April 2021, medium and large organisations in the private sector have been responsible for determining the tax employment status of people who work for them through an intermediary.

The rules have proven controversial ever since they were announced, with the most recent concerns coming in the form of reports from the National Audit Office (NAO) and the House of Lords last month.

The NAO published its investigation into the implementation of IR35 tax reforms on 10 Feb 2022, focusing on lessons learned by HMRC from the 2017 reforms in the public sector, and how these have been applied to the 2021 rollout.

On the same day, the House of Lords published a follow-up inquiry on its 2020 report on the legislation, outlining new findings - including an increase in umbrella companies, and a call for better focus on employment rights.

Meanwhile, HMRC says it has commissioned external research into the short-term effects of the reforms in the private sector, which it plans to publish in 2022.

IR35: the story so far

IR35 rules were first introduced back in 2000, with the aim of preventing tax avoidance by so-called ‘disguised employees' - people who worked in essentially the same way as an employee, but do so through an intermediary, such as a limited company, to pay less tax.

Workers were initially required to determine their own employment status under the rules, but in April 2017, reforms in the private sector meant that responsibility lay instead with the public body that hired them.

Similar changes were then rolled out in the private sector in April 2021, requiring medium and large businesses to determine their workers' tax status.

A "soft-landing period" applied, however, meaning no fines would be handed out for non-compliance with the IR35 rules up until 6 April 2022.

What do the reports say?

The NAO's report concluded that while the 2017 reforms achieved their primary purpose - namely, to reduce non-compliance and raise tax revenue - they were rushed and difficult for public bodies to implement, making it "highly likely" that mistakes would be made.

It said some of these lessons were applied to the 2021 reforms, as HMRC gave businesses more time to prepare and more support in complying with the rules.

Because of inherent differences between the public and private sector, however, the NAO warned that HMRC will have "new risks" to manage, making it much harder to identify, monitor and address non-compliance.

The House of Lords follow-up inquiry, meanwhile, found that the extension of the rules in 2021 appeared to have resulted in an increased use of umbrella companies.

The number of individuals using these companies had already risen from an estimated 100,000 in 2007/08 to 500,000 in 2020/21, and evidence suggested this trend was continuing since the implementation of the rules.

The sub-committee carrying out the inquiry said it was "very concerned" by the trend, as it increases the risk that workers will become involved with "rogue" umbrella companies operating tax avoidance schemes.

It also called for HMRC's external research to be completed more quickly and made more comprehensive, focusing not only on engagers but on contractors themselves too.

Finally, the House of Lords recommended that the Government take a "more coherent approach" to the issue of employment status, including both tax and employment rights.

It said it is "unfair that individuals are treated as employees for tax purposes but without the rights which are normally associated with employment".

To address this, it reiterated that the Government should implement the proposals set out in the 2017 'Taylor Review of Modern Working Practices'.

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